Outsourcing involves moving some of the internal activities of a firm to outside provider(s). The supplier replaces some internal capacity and production through a binding agreement defining the terms, costs, and duration of the procurement. The means of production are transferred to the supplier, which can be a benefit but also carries risks.
The primary rationale for outsourcing is primarily related to the ability to find lower input costs for the good or service, which is particularly relevant when it is standard and easy to replicate. This enables better cost control and frees up internal resources that can be utilized more effectively for core activities that are most valuable. In other cases, outsourcing allows access to capabilities that would otherwise not be internally available, particularly when it involves specialized goods, parts, or services.
There are three sectors where outsourcing dominates:
- Services. Administrative, engineering, research, development, or technical support processes.
- Manufacturing. Fabrication, assembly, and customization.
- Distribution. Transportation, packaging, and warehousing, services that can be provided by third-party logistics firms.